Secular stagnation and the cycle

In this report, I summarize, critically assess and draw out some practical implications of Larry Summers’ secular stagnation thesis, which he reiterated in a talk to the Economic Club of New York just over a week ago.

Summers’ thesis seems to me to have a lot of merit. The secular forces he mentions seem to be strongly embedded in long-term yields and likely to remain there. But they do not dominate the cycle or obviate the need for further Fed tightening — to slow demand growth towards trend because the labor market overshoots in a potentially destabilizing way.

If this is the right take, it is probably for now a continued bear flattener in fixed income. To monitor that possibly changing, we will need to watch the data and the path of financial conditions, tricky as it is to measure the latter precisely. We also need to keep an open mind about the possibility of financial conditions tightening abruptly, not in response to gradual Fed tightening, but because of a financial shock from domestic risk asset prices or possibly overseas.

In contrast, the possible changes in the apparent force of secular stagnation are likely to be secondary.